The interesting thing about Tuesday’s, September 6th, ’22’s price action was that crude ended the day flat or just slightly higher after OPEC announced the production cut over the weekend, and in addition, with the NordStream1 announcement on Friday, September 2nd, ’22, natural gas also did very little yesterday, despite what is being spun as horrid news for natural gas users across Europe this winter.
The expectation (at least I thought) was that crude oil and natural gas would have been screaming higher at the open on Tuesday morning, September 6, 2022.
Have we reached maximum bearishness for Europe ? After the Nordstream1 headline, it seems hard to believe that the headlines could get much worse.
Click on the above chart to expand it. Gary Morrow, a technician this blog religiously follows, posted this chart to LinkedIn today, whereby I promptly asked him to expand the chart so I could show it to readers, and it shows a potential reversal in the UDN (dollar bearish ETF), which means that the dollar could be on the verge of weakening, which (in my opinion) could be a big plus for the US stock and bond markets.
The UUP is the dollar-related ETF that I’ve written about frequently over the last month, as the dollar index has reached 22 years highs. While a strong dollar is actually deflationary, it’s been too strong and it impacts capital flows and also quarterly earnings. At first the dollar impact on SP 500 revenue is “translational” meaning it impacts or influences non-US revenue within a company which then must be “translated” or adjusted to reported revenue, and the influence is mostly minor, but after a long run of strength or weakness, the dollar effect becomes “economic”, meaning it materially influences trade flows.
It’s still easy to remember the G-6 (or maybe by then it was the G-7) meeting in the mid 1980’s after the dollar screamed higher on President Reagan’s economic policies. That dollar strength caused a lot of pain in the Rust Belt in the Midwest or Heartland of America as basic material industries and grain exporters were just crushed on the dollar’s strength, and it lasted at least 3 – 4 years too, before the central bank coordination started after that G-7 meeting to gradually weaken the buck.
Why is the dollar so strong today?
Reaching all the way back to my CFA exam prep days, the three big influences on relative currency action is:
- Relative monetary policies;
- Relative fiscal policies;
- Relative “real” (inflation-adjusted) interest rate levels;
It’s seem clear now, almost a year into when Jay Powell started jawboning about the coming tightening cycle, that the US Fed would be the first to raise rates around the globe, and by that I mean amongst the Fed, The ECB, the Bank of Japan, and the People’s Bank of China (PBOC). That alone would strengthen the buck, and likely has since if you were a foreign bank or investor, and you knew the Fed would be raising rates for a period of time, wouldn’t you want to own short-term Treasuries, probably the safest security in the world from a credit perspective ?
Relative fiscal policies and relative real rates, I’m not sure how that plays in here. It’s tough to gauge fiscal policies outside the US, and it would only be when inflation falls, and that’s poised to start happening next week with the CPI and PPI data being released (discussed here) where “real” rates would actually start to rise.
To answer the question directly, I suspect that today a lot of the dollar strength is monetary policy-driven, but also it could be the rest of world is still beat down by Covid and it’s aftermath, including China and Ukraine is probably no small influence as well.
Keep an eye on the UUP (dollar bull ETF) and UDN (dollar bear ETF) over the next week or so. As was mentioned in a previous post, the UUP can’t be bought for clients because it generates a k-1 and even if it’s bought in an IRA account, it’s purchase can generate a distribution or even alter the tax-deferred status of the account (yikes).
Clients are long Oakmark International, the EMXC ETF (emerging markets ex-China) and a small position in the GLD (gold ETF) for a play on dollar weakness. (This doesn’t mean that the instant the dollar weakens, these positions will outperform, but if you look at the longer-term “annual” returns on all three positions, all are a hedge against the large-cap growth performance premium of the last 5 years.
Last Thursday’s SP 500 low of 3,903.65 is still intact.
Take all this as simply one opinion, and time could prove all this very wrong, and past performance is no guarantee of future results. Capital markets can change very quickly and lousy markets can last for a very long time, much longer than you think.
Thanks for reading.